Republicans dropped their tax proposal Thursday leaving taxpayers in all brackets and situations grappling to understand how the new plan might impact them. Republicans are looking to make some seriously big changes to the U.S. tax code, and among the proposed changes is an elimination of "special interest deductions." While eliminating those deductions is bound to impact taxpayers across the board, the GOP tax proposal could stand to impact millennials in a major way. How? Two words: student loans.
Under current tax law — and with certain restrictions — interest paid on eligible student loans can be deducted from your total taxable interest. However, in looking to axe "special interest deductions," the GOP's new tax proposal could eliminate the current student loan interest deduction. And while the current student loan interest deduction isn't a perfect benefit that all with student loans can receive, nixing it could still have a major impact on millennial taxpayers.
"Students graduate with enormous debts, that's well known," Stanford University tax law professor Joseph Bankman tells Bustle. "If you can't deduct your student loans, we're really increasing the cost of education."
To better understand what Bankman means, let's dive deeper into how the student loan interest deduction works. Currently, you can deduct up to $2,500 of student loan interest paid during the year if your yearly income falls below $80,000, or $160,000 if married and filing jointly. However, like most tax benefits, there are some additional restrictions.
Only student loans from qualified sources are eligible. Meaning if you borrowed money for school from a relative, your next door neighbor, a friend who came into an unexpected windfall, or even your employer, you're not able to deduct the interest you've paid on your loan. Moreover, when you took out the loan, you had to have been enrolled as at least a part-time student at what the IRS defines as an "eligible educational institution."
And there's more. If your income falls between $65,00 and the cap of $80,000, the deduction will be slowly reduced until you reach the upper limit.
However even with all the complicated regulations and restrictions, the student loan interest deduction can be a major tax benefit for some. For example, let's say you make $40,000 a year and are slowly paying off a mountain of student loan debt so large that you pay at least, if not more, than $2,500 in interest each year on it. On your taxes, you claim the maximum deduction of $2,500, reducing your total taxable income to $37,500.
Now, here's where the benefit comes in. In cutting $2,500 off your total taxable income, the student loan interest deduction has dropped you into a lower tax bracket (according to the 2016 tax brackets for individual filers), meaning you'll end up paying slightly less in taxes.
According to Bankman, eliminating the student loan interest deduction would be the equivalent of disinvesting in human capital, or what economists refer to as the skills, knowledge, experience, and training that an individual uses to perform a job that produces some kind of economic value.
"That's the kind of bottom line way to look at it," Bankman tells Bustle. "This act is about giving breaks for financial capital so that people that own stock and companies that are making investments in financial capital or physical capital are getting enormous tax cuts."
But Bankman says that, in the long run, wealth truly lies not in financial capital, but in human capital.
"While it's important to give companies a break perhaps so they can expand physical and financial capital, in the long run human capital is more important," Bankman tells Bustle. "This is a provision that just increases the taxes on human capital and moves us in the wrong direction."
While the full impact of a potential elimination of the student loan interest deduction is still being examined, axing it is bound to have affect a large number of taxpayers in one way or another. According to the IRS, more than 12 million taxpayers took a student loan interest deduction in 2015.
If Congress approves the GOP's plan and the deduction is cut, some may find they're hit with a higher tax bill or a significantly smaller return. Either way, this could be one of the proposals that millennials feel the most.